In this episode, we discuss how companies are preparing for a mild recession, the developing decade of AI, and the status of the reopening of China.
The episode is based on yesterday's newsletter which is available on Substack.
A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.
Show Notes
00:00:00 Introduction
00:00:07 A Mild Recession Ahead
00:02:12 Will the Fed Slow Down?
00:04:36 Pace of Decline in VC Investments Slows Down
00:05:32 The Decade of AI
00:09:38 Nearshoring and the Reopening of China
00:10:58 Conclusion
Introduction
[00:00:00] Scott: Hi everybody. Welcome to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of The Transcript, along with Erick Mokaya, who's our lead author.
A Mild Recession Ahead
We sent out a new issue of the newsletter yesterday, and it was the first big week of earnings last week. So we got a lot of different companies talking about what they're seeing in the economy. What we saw was that there were a lot of references to maybe a mild recession. I think we're in a place where people are feeling a little bit optimistic about the state of the economy, and yet are still concerned about recession and/or see the trend towards recession. And so people are thinking maybe considering that the consumer is still in pretty strong shape, have strong balance sheets and seem to be spending, and labor markets are still strong. Maybe you get a mild recession and then you splice that with the fact that the Fed is still talking about raising interest rates, but noticing as well that inflation is coming down some, but they seem to be honed in on this services inflation rather than goods inflation, are starting to focus more on that being elevated in like the 4.5% region. But in order to tackle that, they'll need to see slowing wage increases. Those were the things that stood out to me this week. Erick, any thoughts?
"The consumer spending across our customer base has slowed…But that consumer spending is strong…So far this month actually, it’s back up 6, 7%…The consumers have money in their accounts. They spend it down a little bit. They still have a lot there. So, my belief is a mild recession." - Bank of America (BAC 0.00%↑) Chairman & CEO Brian Moynihan
[00:01:13] Mokaya: I think on the macro section you've picked up the key things. It's just an air of caution. And I think that's what you pick from even the tech companies that continue to do layoffs last week, especially Microsoft. I think they point out that there's an air of caution from their customers so far. Even though spending is still strong, I think Bank of America pointed out that spending is slowing down. So I think that's what is making people a bit more cautious. But I think also something else we noted there is the Fed Reserve Bank of New York president saying that they expect a period of below-trend growth. And I think you captured it as it appears the Fed wants to have a mild recession. So I think then, seems like then we will have this recession, it seems that the Fed wants it and the people are expecting it. And because of that then companies are making an error on the side of caution, in the sense of making layoffs in anticipation of the tough times ahead. So it seems like everyone is prepared for a recession, but what if it doesn't happen? That's the big question.
Will the Fed Slow Down?
[00:02:12] Scott: Yeah. There were a bunch of Fed governors who spoke last week and they were on a pretty unified page, it seemed like in terms of the way that they were talking about the current environment, and I think that the actual transcripts of the Fed conversations are running slightly differently than the reporting of where people are thinking that the Fed is. The headline of the Wall Street Journal today is that the Fed may slow its pace of increases to a quarter point. And it does seem like that's coming through, but the Fed Governors are still talking about we need to keep raising interest rates, that inflation is higher than it should be. And even though there has been a decrease, again in goods inflation, services inflation is still concerning to them. So I think this divergence between what the Fed is saying and what's being reported that the Fed is saying creates the gap for potential continued disappointment in capital markets at Fed Hawkishness. So until they really start changing their rhetoric, I don't think that the interpretation of slowdown is the correct…
"Even with the recent moderation, inflation remains high, and policy will need to be sufficiently restrictive for some time to make sure inflation returns to 2% on a sustained basis." - US Federal Reserve Vice Chair Lael Brainard
[00:03:18] Mokaya: The Fed meeting is next week. So then we'll get to a feel of where they really are this time hopefully. My expectation is along what the Wall Street Journal says, a bit of a step down to 0.25 in terms of the interest rates increases, but again, I think they won't stop for now. That's the general thoughts. But something else that I noted in the financials is that of course Bann planning behavior is becoming tight, but retail investor interest in public markets has faded. Seems like the increase in interest rates could be having a bit of an impact in terms of maybe the extra money that retail investors had to spend and to invest in the stock market. What do you think of that?
[00:03:56] Scott: Yeah, it's interesting. It doesn't seem like a lot of exciting things are happening either in public markets specifically, or capital markets broadly right now. Even last week was the beginning of earnings season, but you and I were both talking about it, it didn't seem like there was that much new information that was coming out during that. And then there was so much focus among even retail investors during the Covid period. Maybe partially because people were stuck at home, but the meme stock craze and all of those things. It just doesn't seem like there's that much exciting stuff happening in capital markets. And this is natural and there are cycles in terms of interest and disinterest in public markets and we seem to be on a downswing here.
Pace of Decline in VC Investments Slows Down
[00:04:36] Mokaya: It does feel so, but I think somewhere else where it's having an impact, I think one of the quotes was about the private markets. I think SVB is saying that the rate increases are actually having an impact over there, especially on early stage where you have a lot of companies reducing maybe the rate of investments and a bit of an increase in terms of delinquencies in some of the VCs. Are you seeing the same in terms of the startups? Are you seeing anything like that, especially in private markets since you operate there quite a bit?
“We have seen four consecutive quarters of declining VC investment, but the pace of decline appears to be slowing…In the near-term, we expect VC investment to remain pressured, but should see the balance of client fund flows improve as clients continue to reduce cash burn." - SVB (SIVB 0.00%↑) Financial Group CEO Gregory W. Becker
[00:05:02] Scott: Yeah. I think the quotes that stood out to me in this week's newsletter were about how long capital markets have been frozen, both in public and private markets really 13 months now since the beginning of last year, and that being a very long window of being closed. But actually, the rate of change in that closure seems to be getting less bad at the venture level. And then also at even like in investment grade debt issuance, we picked up.
The Decade of AI
And then I think like in private markets, the thing that has my attention and we're picking up in The Transcript is AI and how much that is a transformative technology and what the world looks like from a tech standpoint with powerful large language models. Any thoughts on any of that?
[00:05:49] Mokaya: I think I've just been surprised by how the release of chat GPT has transformed conversations, especially in the tech circles. So I think suddenly out of nowhere now in the past one month or two suddenly every tech CEO and every tech executive is actually having to address the issue of what they're doing in terms of being well positioned for the decade of AI that is coming. So I think now would be a good time to start maybe identifying some of the companies that may start to benefit in this kind of AI decade and try to see which ones are best positioned in that regard. So I think obviously one of the ones that is most commonly mentioned is Microsoft, but maybe behind that, AI requires a lot of chips and a lot of technology also to support it. One of the quotes we picked is about most of the AI development having been in the cloud. So cloud developers or cloud players are some of the beneficiaries of some of these. So I think we were talking also about how we are going to use AI in the transcripts. I think the general feeling you get from the transcripts is that you better be well-positioned to take advantage of AI in your business going forward. Do you sense the same?
“...you can fully expect us to obviously every product of Microsoft will have some of the same AI capabilities to completely transform the product...The best way to prepare for it is not to bet against this technology, and this technology helping you in your job and your business processes" - Microsoft (MSFT 0.00%↑)CEO Satya Nadella
[00:06:55] Scott: Yeah, I think it really changes the fabric of the way a lot of people interact with the economy.
And there are a lot of people who are impacted just by the state of where large language models are now, let alone where they're going. And I think they have the potential to adapt and improve so fast that trying to figure out what point to run to as a human versus these models is a challenge. So I think there's probably a lot of brain cycles being spent on this right now.
[00:07:19] Mokaya: Definitely. I think it's all about, I think seeing how can you position yourself next to the AI to benefit from it. And there's going to be a lot of reskilling and retooling yourselves to see what can AI do and what can I do?
Because when you read most of the letters from the CEOs who are laying off, Google and Microsoft they're not laying off people within the AI segment of the business because they know that's the next phase. So they're laying off everywhere else except that. And one of the quotes that stood out also for me was the Qualcomm one, where he was saying semiconductor production is going to have to double in the next decade as AI begins to scale up and take up a lot of computing power. So it needs a lot of computing power and that computing power is going to come from semiconductors. So that's one of the beneficiaries scaling in AI.
"We expect that in the next decade, we’re going to have to double the total global manufacturing of semiconductors. Semiconductors, it’s going everywhere because everything is becoming connected intelligent. So the key thing is we need to build a very resilient supply chain, and part of that is it’s important to be geographically diversified." - Qualcomm (QCOM 0.00%↑) CEO Cristiano Amon
[00:08:04] Scott: Yeah, you look even at the work that we directly do, and I think in tracking AI development over the last five years, I had always thought we had at least a 10 or 15-year runway before AI models would be able to come close to replicating the types of things that we're doing. I think that assumption has been pulled in a lot based on what we see from chatGPT, that AI models may be able to do the types of work that we're doing within the next couple of years. And so the question for us is what type of value do we uniquely create at The Transcript that AI won't be able to, if any? And then we need to be able to invest in those areas and think about how we are adapting and leveraging the tools that AI brings because ultimately it should just make us more efficient at the types of things that we're doing really well. We are a microcosm, we happen to be large consumers of qualitative verbal data. And so like we're square in the crosshairs here in some ways. But if I were an attorney, I would be thinking the same thing. If I were a journalist, I would be thinking the same thing. If I were in marketing, I would probably be thinking similar things. And even software engineering. We know that these are capable of building semi-complex code right now.
[00:09:19] Mokaya: Definitely I think we have to leverage AI. It’s the decade of AI as they're calling it. So I think we have to be well-positioned for that. And I like how you're putting it. It's about seeing what unique value do I as a person have, and how can I use AI to complement that? How can I use AI to help me be better at what I'm doing currently?
Nearshoring and the Reopening of China
"On the manufacturing side, near-shoring continues to be the most robust trend driving demand in our markets. We estimate 3/4 of demand came from these opportunities. Shifts in the supply chain is making companies make long-term decisions towards regionalization, relocating all manufacturing process to our markets. Mexico is very well positioned to continue levering this opportunity in the years to come." - Prologis Property Mexico CEO Luis Enrique Guajardo
Anything else that you may have picked from the transcript? Maybe one thing that I wanted to highlight is something we picked up last month about Mexico and reshoring. It's pretty interesting that apparently demand for warehouses in Mexico is actually increasing very rapidly. It seems like a lot of companies are really rethinking moving away from China to near the US. Any thoughts on that before we close?
"Just to give you some examples specifically of what happened on the ground in China, and why we are a bit cautious on the post-Chinese New Year. When things opened up in mid-China -- I'm sorry, mid-December in China, we've got 19 PPG manufacturing sites across the country. And we went from near 0 absenteeism very quickly to above 50% absenteeism across that whole network. And that has returned very rapidly to near 0 in a period of about 2.5 to 3 weeks." - PPG Industries (PPG 0.00%↑) CEO Timothy Knavish
[00:09:59] Scott: Yeah, no, I think that the China reopening dynamic is really interesting to be watching and figuring out to what extent China's reopening here is going to impact the global economy, commodity prices for one, and then just supply chains in general when we finally have, full kinks out of the supply chains. It certainly looks like from at least the PPG quote that we put in the newsletter it looks like they're having a sort of omicronous reaction to Covid, where you had a big spike in infections and then it falls off very quickly. PPG talking about absenteeism at their plants, going from 0% to 50% to 0% in over the course of three weeks. It's possible they come back from the lunar New Year and the economy is in full gear. All that said, I think geopolitical tensions and covid make everybody try and think about onshoring or nearshoring supply chains. And so Mexico, to your point, as a beneficiary is a very interesting geography.
Conclusion
[00:10:58] Mokaya: Yeah, so I think we'll be keeping an eye on all this. I think there are 88 companies reporting this week in the S&P 500. So lots of transcripts to go through. We'll leverage our AI skills, for now, to be able to read as many of those as we can and cover them in our newsletter next week. So, thank you so much to those who will be able to sign up, become a paid premium subscriber to The Transcript to support our work, and definitely keep enjoying more of our thoughts and help us to take The Transcript in the decade of AI. Thank you so much and join us again next week. Bye.
The Decade of AI